Saturday, January 21, 2012

With continued volatility in stock markets, today King World News wanted share, with our global readers, key portions from the latest Investors Intelligence report: “Indexes all closed higher again for the second week of the New Year although the advance did moderate. European debt woes again become a factor as S&P downgraded nine EU nations. There were also some disappointing results for the current quarter. However, even taken together those could not move the markets down and each small morning sell-off was met with new buying and at least a partial recovery at the close.” (more)

Either “Risk-Off” assets such as bonds reverse lower from resistance, which suggests “Risk-On” assets like stocks break higher, or vice versa.

As of the last few days, the structure has tipped in favor of “Risk Off” assets beginning an early potential reversal, though we’ll need to see price break firmly under their respective rising daily trendlines and 50d EMAs where they stand now.

In other words, while we still could see a bounce higher in bond prices off the 50d EMA (reference early November 2011), further downside price action suggests a high probability for the “Risk-Off” Asset Reversal lower and “Risk-On” Asset Continuation higher thesis.

Though I don’t show it in a separate chart, the S&P 500 broke tentatively above 1,300 and closed the week at 1,320 on a seemingly hesitant (not compellingly impulsive) breakthrough.

The Dow Jones almost completed a full retest of its 2011 high which will be a critical ‘price resistance’ area to watch closely.

For a longer perspective on bond funds, let’s view the monthly structure for IEF:

A quick price-based look shows us a lengthy, overextended rally scraping above the upper Bollinger (volatility) Band near $105.

We can see historically how two similar overextended rallies ended – with a clean retracement back to the rising 20 month EMA (which was a buying opportunity).

So unless the structure changes dramatically with a sudden upsurge in bond prices – and yes that could happen – the simple chart-based odds seem to favor weakness for bond prices, particularly on a trigger under the daily chart trendlines and EMAs shown above.

Jim welcomes back John Williams from Shadow Government Statistics. John sees no way to avoid hyperinflation, as some of the warning signs are getting worse: rising real inflation rates, massive Fed monetization, foreign nations dumping dollars, and the US losing its triple A credit rating.

Despite a handful of economic reports that didn’t quite measure up to expectations, stocks gained for the third consecutive session. The catalyst for the rise was a drop in jobless claims and better-than-expected earnings from Bank of America (NYSE:BAC). And the euro rose by 0.8% against the U.S. dollar, which also had a positive impact on stocks.

At the close, the Dow Jones Industrial Average was up 46 points to 12,625, the S&P 500 rose 6 points to 1,315, and the Nasdaq gained 19 points at 2,788. The Big Board traded 805 million shares and the Nasdaq crossed 497 million. Advancers beat decliners by 2-to-1 on the NYSE and by 1.4-to-1 on the Nasdaq.

There is much to study in today’s chart of the Dow Jones Transportation Index, which broke to a new high yesterday. It is considered to be the measuring tape for expected economic growth, and so a dramatic move by this index is noteworthy. The transports have been in a bull channel since November, and we confirmed a triple-top breakout in our Jan. 4 Daily Market Outlook.

This is a powerful chart with not only a visible bull channel but a new confirming high from its Relative Strength Index (RSI) and a pending golden cross (bullish crossover of 50-day moving average through the 200-day moving average) possibly just a day away. But a spike like yesterday’s 84-point (1.6%) advance is often followed by profit-taking.

Note that the index has advanced to almost the exact midpoint of the October 2010 to July 2011 consolidation — a thick zone of potential sellers. And also note that its RSI, though confirming the uptrend, is at its highest level since October 2010.

Short-term conclusion: The market, though still very strong, is reaching overbought levels. And with January options expiring today anything can happen. Rather than chasing stocks at this level it would be more prudent to buy on pullbacks. And if you’re looking for help making quick profits, you may want to check out my colleague Joe Burns.

Longer term conclusion: The Dow Jones Transportation Index may be telling us that a breakout will eventually occur — remember, it is this index that is most efficient in predicting future economic growth. And, it is an accepted fact that presidents will use their power to boost the economy in the election year concluding their first term in office. This record of the performance of the S&P 500 confirms the power of the presidency in economic matters.

If Wall Street's stock tips were reliable, portfolio selection would be easy. Investors could simply load up on Apple (AAPL: 427.75, -1.36, -0.32%) because analysts give it more positive ratings like "buy" and "outperform" than any other stock, according to Thomson Reuters (TRI: 28.85, 0.39, 1.37%) data.

Alas, the historical evidence shows stocks with lots of "buys" don't do better than the broad market, on average.

Perhaps that is because so many companies are showered with love. Among those in the Standard & Poor's 500-stock index, there are 10 times as many "buys" as "sells."

But new research suggests a way for investors to tell which "buys" are worth heeding and which ones aren't.

Professional stock-pickers have had an image problem at least since a 1933 study by economist Alfred Cowles confirmed what the market crash of 1929 had amply demonstrated: Stock forecasters can't forecast with any accuracy.

A landmark paper published 16 years ago in the Journal of Finance offered some redemption for analyst recommendations. It divided returns into two components: an initial pop when a new recommendation is announced, and a gradual drift in the months that follow. The distinction matters because ordinary slow-poke investors can take advantage of drifts but not pops.

Two key findings: First, analyst recommendations are like dairy products in that it is best to use them quickly or not at all. Shares tend to drift in the direction of recommendation changes, but for weeks or months, not years.

Second, "sells" tend to be far more prescient than "buys." According to study author Kent Womack, a former Goldman Sachs executive who now teaches finance at the University of Toronto, analysts face little resistance to their "buy" recommendations but risk angering companies and investors with their "sells," so they tend to issue sell calls much more judiciously.

That takes some of the shine off of Apple. It has received no fresh "buys" within the past four weeks among firms polled by Thomson Reuters.

Other members of the S&P 500 index have received multiple "buy" recommendations of late, including upgrades and coverage initiations. Among them are web retailing giant Amazon.com (AMZN: 194.45, 5.01, 2.64%) and Devon Energy (DVN: 64.15, -0.25, -0.39%), an oil-and-gas producer.

What's needed is a way to find better "buy" ratings. Mr. Womack presents some new thoughts on that in a working paper with Ambrus Kecskes at Virginia Tech and Roni Michaely at Cornell University.

To form their recommendations, analysts often begin with something called discounted-cash-flow analysis, which uses forecasts of revenues, margins and many other factors to determine a fair share price for investors to pay today. Some factors are difficult to measure (like riskiness), others are impossible to know (like distant growth rates) and subtle changes in the assumptions can produce sharply different results.

In other words, with a pinch here and a prod there, analysts can make the math say anything about a stock.

The three authors theorize that the best recommendation changes are ones that stem from concrete new information, and that changes in near-term earnings forecasts are a good sign of such information. In the study, they find that stock prices drift much more when recommendation changes are accompanied by earnings-forecast revisions.

The authors calculate that between 1994 and 2007, a trading strategy of buying stocks following raised ratings and earnings estimates and holding for a month, while doing the opposite (short selling) for stocks following lowered ratings and estimates, would have returned more than 45% a year. That is several times what an S&P 500 index fund would have returned over the same period.

Ross Stores (ROST: 51.13, -0.36, -0.70%), a clothing chain, Broadcom (BRCM: 34.99, 1.64, 4.92%), a chip developer, and Discover Financial Services (DFS: 27.13, 0.21, 0.78%) have gained new analyst endorsements within the past four weeks and seen their earnings forecasts raised. Their shares are off to a strong start this year, up 7.6%, 8.4% and 9.5%, respectively, through Friday.

There is another way investors might be able to improve on analyst picks. That is by using analyst math in reverse, says Julian Koski, co-chief executive of Guggenheim Transparent Value, an investment firm.

"We start with the admission that the future is unknowable, and then we base our math on known measures," Mr. Koski says.

That means starting with the actual stock price rather than constructing a theoretical one. Mr. Koski's method involves calculating the number of widgets a company must sell to justify its current share price, called its required business performance, or RBP. The analyst uses the company's recent results as a guide in determining the probability it will achieve its RBP.

The RBP percentages change daily according to stock price. Mr. Koski points to Netflix (NFLX: 103.46, 4.92, 4.99%) as an example of a recent success. It had an RBP probability of below 5% last summer, when the stock price was over $280, but shares have since plunged below $100, and the stock recently had an RBP probability of nearly 90%.

An index that selects 100 stocks with the highest RBP probabilities, the Dow Jones RBP U.S. Large-Cap Core Index, has returned 10.8% a year in back-testing since 1998, versus 2.1% for its benchmark, the Dow Jones U.S. Large-Cap Total Stock Market Index.

In the last few years I’ve noticed that many of the cable finance and housing shows highlight families in Canada. Shows that talk about debt or home buyers are usually focused on families in Canada which is rather odd given that we are here in Southern California. Yet the funny thing about these shows is that they rarely identify that they are in Canada although I recognize locations like Vancouver. If one simply tuned into the show it would appear that a bubble was still going on in the states. This is probably the point. After all, the cable shows focused on flipping houses or making quick bucks on real estate started going off the air yet another bubble was still going on up north. Obviously these shows had an audience otherwise they would not be on the air. Now the focus is on the Canadian bubble and American audiences can swim in the nostalgic dreams of the glory days of domestic housing. Yet the shows rarely mention their location as if English-speaking families and cookie-cutter condos and homes are so easily interchangeable that they will fool an audience. Yet one thing the shows fail to acknowledge is that the Canadian housing bubble is even more pronounced than that in the United States.

Canadian housing bubble set to burst

Let us first get one thing out of the way; the Canadian housing bubble will burst. Just like real estate bubbles in Ireland, Spain, England, and the United States real estate bubbles do burst. Timing is always hard to predict but undoubtedly these bubbles pop because they are fueled by easy and hot money. Even at the apex here in California arguments were bandied around regarding foreign money, low interest rates, and other nonsense trying to support a ludicrous bubble. Once the ego was put on the shelf and the credit markets imploded, the housing market came crashing down. Canada seems to be where the United States was in 2007. Let us examine a couple of charts:

The U.S. housing market peaked in 2006 and it looks like Canada is five-years behind the curve. The rise in Canadian real estate is simply unjustified. Household incomes in Canada have not come close to keeping pace with real estate values in each respective market. Take a look at the insane Vancouver market:

Real estate values in Vancouver have shot up by 142 percent since 2002. There is absolutely no justifiable reason for this except for massive speculation. Let us look at household incomes for this area:

The median household income in Vancouver is $67,550 yet the average detached home price is above $1 million. That is simply madness and even makes the California housing bubble look modest in comparison.

Internal warnings of a bust are already running rampant:

“(CBC) The influx of multi-unit builds has led some economists to warn of overbuilding in the Canadian housing market, which could leave a glut of unsold homes on the market in the case of a downturn.

A downturn in demand would also likely lead to an easing of Canadian home prices, which The Economist magazine recently declared are about 25 per cent overvalued.

Interest rates are not expected to increase in the coming year, but analysts noted that Canadian households are already at record high debt levels, and the growth of both jobs and income has stalled.”

Canadian households are in deep debt just like U.S. households. Even some of the “financial rescue” shows highlight Canadian families that suffer from the same delusions as many American households. You see the same patterns that led us into this crisis:

-“I can’t give up our home!” – a person in massive debt who really can’t afford their home

-“But we can’t give up our condo!” – trying to buy a $600,000 condo with a $60,000 household income

-“We are doing fine.” – a family in deep credit card debt and a negative net worth

It is little wonder why television programmers have merely swapped out American families for Canadian families. The pattern is the same and aside from a few glances at Canadian cash, these families are replicating the same debt hunger of American families during the bubble heyday.

Canada bubble locations use same bubble logic as peak U.S. locations

The bubble talk is similar in locations with major bubbles like Vancouver. By the way, I think Vancouver is a great place but it is in a major bubble. A lot of hot money from outside has inflated values:

“(The Province) Cam Good, president of The Key, a Vancouver-based real estate marketing firm that caters to Asian buyers, said that about 60 per cent of the estimated 1,500 condos he sold this year, in Vancouver and Toronto, were to Chinese buyers.

While an October report by Royal LePage recorded a 16.9per-cent price increase of a standard two-storey house in Vancouver ($1.142 million) compared to the same time last year, local realtors and experts think restrictions are the last thing Vancouver’s market needs.

The report, which defined Vancouver as composed of the city’s east and west sides, West Vancouver and North Vancouver, pegged the average price of bungalows and condominiums at $1.02 million and $513,500, respectively.”

Patterns like this are short-term just like Japanese buying in California during a previous bubble. These bubbles will burst because any housing market is going to be supported over the long-term by local households and what they can afford. These short-term speculative bubbles simply become landing grounds for hot money. The home price-to-rent ratio is already absurd in Canada:

Source: Gluskin Sheff

While many in Canada and places like Vancouver would like to deny a real estate bubble it is rather obvious to most outsiders. The bubble will burst and is looking very close to reaching a peak already. All the arguments and justifications were played out here in California as well. This is something that is very familiar especially now that we enter year five of the housing market crashing here in California. And just like the U.S. fringe markets pop first:

“(The Globe and Mail) What drives the housing cycle up, inevitably drives the market down as well. Builders in the multi-unit segment are currently responding to elevated home prices and robust pre-construction sales. Anecdotal evidence suggests the vast majority of pre-construction sales are to investors who intend to sell the units on completion or rent them out. As these condos in the construction pipeline are completed, this inventory of units will be dumped on to the rental and/or re-sale market just as sales momentum and housing demand ebbs. Our estimates indicate there will not be enough renters in Toronto to occupy these units as they are completed. As a result, some investors will be left holding vacant units. Since most investors are unlikely to hold onto negative-carry investments without a reasonable prospect of price appreciation; this will put downward pressure on home prices. We have already seen this dynamic play out in some smaller markets on Canada’s west coast where prices have corrected 15 per cent.”

Welcome to your housing peak Canada. The good news is that things will continue even after your real estate bubble pops. In fact from data I have seen and stories I have heard, many of those harmed by the current real estate bubble are your local families who are unable to purchase without going deep into debt.

Last week's selling in the euro currency, due to increasing worries that the euro zone economy will continue to weaken, took prices to more than a 16-month low against the U.S. dollar. Pressure on the euro resulted after the Federal Statistics Office said Germany's economy probably contracted in the fourth quarter by .25% from the third quarter, while the European Union reduced their euro zone growth estimate to .1% in the third quarter from the .2% growth they had previously estimated. In addition, a Bloomberg survey showed the euro zone economy will probably shrink by .2% this year.

EURO CURRENCY FUTURES - MONTHLY CONTINUATION

Chart provided by APEX

Another ominous indicator of the future of the euro zone's economic outlook was the shocking results of a German Treasury bill auction. Germany sold six-month Treasury bills at a negative yield for the first time ever. The 3.9 billion euro offering, maturing this July, was sold at a negative .01% yield. This unprecedented negative yield is a clear sign that investors are attempting to preserve wealth, rather than to maximize income, as evidence grows that the euro zone will enter into a recession. In addition, some of the recent weakness in the currency of the euro zone was attributed to last week's lukewarm demand for the 10-year German bund auction.

The future of the euro currency came more into question on Monday when the euro zone's bailout fund, the European Financial Stability Facility, lost its top credit rating. This took place after Standard and Poor's downgraded the debt of France and Austria by one level on January 13. The new rating from S&P for the EFSF is now AA+, which compares to their previous rating of AAA. In addition, the German retail sales report last week, reinforced ideas that the euro zone is headed for recession. German retail sales declined .9% in November, when a .2% increase was anticipated.

Recent employment news has been mixed. The November unemployment rate in Italy increased to 8.6% and joblessness in Spain advanced to a record 22.9% in November. On the bullish side, German unemployment declined in December by more than analysts expected. The Federal Labor Agency reported unemployment in Germany declined 22,000 to total 2.89 million. A 10,000 decline in unemployment had been predicted by economists.

Not all of the euro zone sovereign debt auctions have been bearish. For example, several of the more recent euro zone sovereign debt auctions were well received. Spain sold 9.98 billion euros of debt, which was almost two times the target of 5 billion euros that had been planned and Italy sold 8.5 billion euros of debt at a yield that was much lower than dealers had anticipated.

Some traders have been encouraged by the recent well-received debt auctions in the euro area. However, much of the demand for all of this debt is probably coming from banks that have recently accepted massive amounts of three-year loans from the European Central Bank. Therefore, the recent better than expected euro area debt offerings may not be that bullish for the euro after all. Some of the strength in the debt offerings was due to comments from European Central Bank President Mario Draghi when he said his strategy to avert the euro area's financial crisis is working.

Also supportive, at least on a short-term basis, to the euro were some of the economic reports that were stronger that analysts had anticipated. For example, there was news that German investor confidence improved from a very low level in January. The ZEW Center for European Economic Research said its index of expectations for business conditions improved to -21.6 from -53.8 in December. A reading of -49.4 was anticipated. In spite of the better number, the economic outlook remains dire.

CONCLUSION

Although there is no shortage of economic and political problems in the U.S., it appears that the strains on the financial system in the euro area are much more severe. The ongoing financial problems in the euro area, including fears that the euro zone economy will enter into a recession are likely to remain well into 2012. There is likely to be increased motivation for market participants to move out of the euro currency and into the relative safety of the U.S. dollar. In the longer term, the euro is likely to continue to be pressured by increasing prospects of a recession in Europe, sovereign debt downgrades, along with bearish interest rate differentials.

The main trend for the euro currency is lower, with the next downside psychological chart objective coming in at 1.2500 to be followed by a test of the 1.2000 level.

The "Chart of the Day" is American Water Works (AWK), which showed up on Thursday's Barchart "All Time High." AWK on Thursday posted a new all-time high of $32.98 and closed up 1.51%. TrendSpotter has been Long since Dec 21 at $31.80. In recent news on the stock, AWK management offered guidance for FY2011 EPS of $1.75-$1.82 versus the consensus of $1.78 and FY2012 guidance of $1.90-2.00 versus the consensus of $1.91. Ladenburg on Jan 11 upgraded AWK to Buy from Neutral. American Water Works, with a market cap of $5.7 billion, is the largest investor-owned U.S. water and wastewater utility company.

Marc Faber, publisher of the Gloom, Boom & Doom report, talks about the outlook for stocks versus bonds and his investment strategy. He speaks with Sara Eisen and Erik Schatzker on Bloomberg Television’s “InsideTrack.” (Source: Bloomberg)

Faber said in the interview, that given the choice between U.S. Treasurys and European bonds, he would choose the U.S. Treasurys; given the choice between equities, real estate, bonds and precious metals, he would choose precious metals and equities.

Eric Schatzker calls Faber out on his bearish 2009 call on U.S. Treasurys, and laughably, Faber admits that David Rosenberg was right, and he owes him a bottle of whiskey.

The January 2011 Consumer Price Index for Urban Consumers (CPI-U) released today puts the December year-over-year inflation rate at 2.96%, which is a full percent below the 3.96% average since the end of World War II.

For a comparison of headline inflation with core inflation, which is based on the CPI excluding food and energy, see this monthly feature.

For better understanding of how CPI is measured and how it impacts your household, see my Inside Look at CPI components.

For an even closer look at how the components are behaving, see this X-Ray View of the data for the past five months.

The Bureau of Labor Statistics (BLS) has compiled CPI data since 1913, and numbers are conveniently available from the FRED repository (here). My long-term inflation charts reach back to 1872 by adding Warren and Pearson's price index for the earlier years. The spliced series is available at Yale Professor Robert Shiller's website. This look further back into the past dramatically illustrates the extreme oscillation between inflation and deflation during the first 70 years of our timeline. Click here for additional perspectives on inflation and the shrinking value of the dollar.

Alternate Inflation Data

The ShadowStats Alternate annualized rate of inflation is 10.57%.

The chart below (click here for a larger version) includes an alternate look at inflation *without* the calculation modifications the 1980s and 1990s (Data from www.shadowstats.com).

On a personal note, the more I study inflation the more convinced I am that the current BLS method of calculating inflation is reasonably sound. As a first-wave Boomer who raised a family during the double-digit inflation years of the 1970s and early 1980s, I see nothing today that is remotely like the inflation we endured at that time. Moreover, government policy, the Federal Funds Rate, interest rates in general and decades of major business decisions have been fundamentally driven by the official BLS inflation data, not the alternate CPI. For this reason I view the alternate inflation data as an interesting but ultimately useless statistical series.

That said, I think that economist John Williams, the founder of Shadow Government Statistics, offers provocative analysis on a range of government statistics. While I do not share his hyperinflationary expectations, at least not based on current economic conditions, I find his skeptical view of government data to be filled with thoughtful insights.